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Since the start of the eight-year bull market, stock prices have closely tracked the size of the Federal Reserve’s balance sheet. But that’s quickly changing.
While the Fed’s balance sheet has stayed mostly unchanged in 2017, the S&P 500 has continued to climb, surging roughly 11% year-to-date. The fact that stock indexes continue to make new highs as the Fed prepares to shrink the assets it holds troubles Byron Wien, the vice chairman of Blackstone’s private wealth solutions group.
“This divergence is disturbing, particularly since the Fed is contemplating a balance sheet shrinkage starting in September,” he wrote in a client note. The role of central bank liquidity is “receiving inadequate attention,” he said.
He’s particularly wary of how the accommodative conditions offered by the Fed since 2009 have been used. While the Fed’s unconventional purchases of assets were supposed to stimulate economic growth, Wien estimates that roughly three-quarters of the proceeds have gone into financial assets like stocks, with only one-quarter invested in the real economy.
Wien is specifically focused on productivity growth, which he notes has been declining almost everywhere worldwide over the past decade, compared to the period from 1996 to 2006. This makes it more difficult for companies to generate earnings growth, which has historically been the biggest driver of stock gains.
Yet while these dynamics have placed a huge weight on the shoulders of corporate profit expansion, US corporations have looked up to the task — at least for now.
Fresh off their best quarter in more than five years, companies in the S&P 500 are projected to grow earnings by 8.8% in the second quarter. The full-year 2017 outlook calls for expansion of roughly 12%, according to data compiled by Bloomberg.
Wien recognizes this, and despite his consternation over stocks continuing to surge as the Fed tightens, he isn’t ready to call the end of the bull market.
“Earnings are expected to break out,” he said. “While the current expansion is more than eight years old, few excesses are apparent and I am optimistic that the next serious downturn is several years away.”